Debtors’ taxes are not discharged in bankruptcy where tax return was filed late

A federal appeals court held that bankrupt debtors who filed their
income tax return 17 months after their income taxes were assessed
were not entitled to have those taxes discharged in the bankruptcy
proceeding (In
re Wogoman, No. CO-11-084 (B.A.P. 10th Cir. 7/3/12)). In
doing so, the court considered what effect a 2005 change to the
definition of “return” had on bankruptcy law’s treatment of tax
returns, but declined to adopt a bright-line rule.

The debtors filed for chapter 7 bankruptcy relief in January 2011,
and the next month they filed a complaint to determine the
dischargeability of their federal income taxes for various years. The
IRS conceded that their taxes were dischargeable (or that they owed no
taxes) for all the years in question, except 2001. The IRS said the
debtors had not filed a return for 2001, and therefore their taxes
were not dischargeable under Bankruptcy Code Section 523(a)(1)(B)(i),
which provides that a debtor is not discharged from any tax debt for
which no return was filed.

The IRS had assessed a deficiency against the debtors for their 2001
taxes in February 2005. The debtors did not pay the assessed
liability, but they did file a 2001 Form 1040, U.S. Individual
Income Tax Return, in August 2006. The IRS then abated part of
their tax liability and penalties, and in March 2007 the debtors
entered into an installment agreement with the IRS.

The IRS argued that the 2001 tax liability should not be discharged
in bankruptcy because, at the time the 2001 taxes were assessed, the
debtors had not filed a 2001 return. The debtors argued that the
express language of Bankruptcy Code Section 523(a)(1)(B)(i) does not
require that the return be filed prior to assessment to be effective
for dischargeability purposes.

The lower court held that the tax debt was not dischargeable because
“it came into existence prior to the filing of the Form 1040 by the
Wogomans in 2006” (In re Wogoman, No. 11-11044 (Bankr. D.
Colo. 8/19/11)).

The Tenth Circuit noted that the Bankruptcy Abuse Prevention and
Consumer Protection Act of 2005 (BAPCPA) added new language to
Bankruptcy Code Section 523(a)(19) to define “return” to mean “a
return that satisfies the requirements of applicable nonbankruptcy law
(including applicable filing requirements).”

The court also reviewed pre-BAPCPA law, which required that the
debtor’s return “must represent an honest and reasonable attempt to
satisfy the requirements of the tax law” (In re Hindenlang,
164 F.3d 1029, 1033 (6th Cir. 1999)). The Tenth Circuit held that
because the debtors did not file a return until after the IRS
commenced an examination, sent them a notice of deficiency, and
assessed the taxes, their 2001 return did not represent “an honest and
reasonable attempt to satisfy the requirements of the tax law.”

When is a return filed too late?

The court noted that the Fifth Circuit has already interpreted the
definition of “return” in Bankruptcy Code Section 523(a)(19) to mean
that a late-filed return is not a return for bankruptcy purposes, even
if it is filed before the IRS assesses the tax (In re McCoy,
666 F.2d 924 (5th Cir. 2012)). Surprisingly, the IRS argued for a
more-lenient standard, and urged the Tenth Circuit to adopt the
position that the time of assessment is the proper dividing line for
determining that a return is filed too late for purposes of Bankruptcy
Code Section 523(a)(19).

The Tenth Circuit was not convinced that the language of Bankruptcy
Code Section 523(a)(19) means that no late-filed return can ever
qualify a debtor for discharge of tax debts, but it said it did not
need to decide that issue in this case. It also declined to adopt the
IRS’s proposal that the time of assessment be the dividing line,
noting that no court has adopted this position.

Here, the debtors’ return was not merely filed late, but was filed
17 months after the IRS had assessed the taxes, and the debtors
provided “no justifiable reason for the delay.” The court held that
this situation clearly failed to meet the requirements of Bankruptcy
Code Section 523(a)(19), under either interpretation of the section
and under the “honest and reasonable attempt” standard. Therefore, the
debtors’ 2001 tax liability was not dischargeable.

The results of the 2016 presidential election are likely to have a big impact on federal tax policy in the coming years. Eddie Adkins, CPA, a partner in the Washington National Tax Office at Grant Thornton, discusses what parts of the ACA might survive the repeal of most of the law.